The world according to Warren

The Oracle of Omaha ponders the American economy

NEW YORK (MarketWatch) -- Warren Buffett's latest annual shareholder letter just arrived. And in these uncertain times, it's more prescient than ever.

Every year, Buffett writes a lengthy letter to shareholders. Devoid of the usual buzzwords and corporate-speak, it's full of original ideas and clever explanations of old ones.

Indeed, Buffett goes down in my book as having that incredibly rare combination of wisdom -- and the wit to explain it well -- found in only two other leaders: Abraham Lincoln and Winston Churchill.

So I thought I'd share his latest on the economy and corporate finance. As you'll see, he had a clear view all along on the mortgage crisis. He remains quite concerned about financial reporting and some of the dangerous financial assumptions made in corporate America, and has a clearer view on trade than most of our politicians. Finally, he sums up, somewhat surprisingly, on an upbeat note.

Most of his letters, available on the Berkshire Hathaway
BRK.B, -0.35%BRK.A, -0.11%
Web site, also give pearls of wisdom on selecting individual companies, and this edition is better than most.

I told you so

Three paragraphs into the 22-page letter, Buffett scolded the lending industry's "financial folly" and the effects of "weakened lending practices," about which trouble was foretold in last year's letter.

"You may recall a 2003 Silicon Valley bumper sticker that implored: 'Please God, Just One More Bubble.' Unfortunately, this wish was promptly granted, as just about all Americans came to believe that house prices would forever rise. That conviction made a borrower's income and cash equity seem unimportant to lenders, who shoveled out money, confident that HPA [his acronym] -- home price appreciation -- would cure all problems."

He followed that with an update of one of his most famous quotes over the years, now pertinent more than ever: "You only learn who has been swimming naked when the tide goes out -- and what we are witnessing at some of our largest financial institutions is an ugly sight."

He didn't offer any further prognosis, but I'd guess he doesn't favor throwing swimsuits into the waves any time soon.

'Fanciful figures -- how public companies juice earnings'

Over the years Buffett has had a lot to say about the improprieties of corporate accounting and the messes it leads to (think Enron and option accounting, for instance).

This year he takes aim at corporate pension accounting. He notes that 363 of the 500 companies in the S&P 500 have pension plans, and that on average they assumed an 8% annual return on pension plan investments in 2006.

So, since 28% of pension plan assets are held in bonds likely to return 5% or less, the remaining 72% of assets held must achieve a rate of return of 9.2% to hit that overall 8%.

As he goes on to state, during the 20th century the Dow rose from 66 to 11,497. Comforting? Yes, but using proper compounding math gives an annualized return of 5.3%, and you can add 2% for dividends. "It was a wonderful century," acknowledges Buffett.

Turning to this century, to merely match the 5.3% gain of last century, starting near 13,000 the Dow would have to close at 2,000,000 on Dec. 31, 2099.

And those expecting 10% annually "....are implicitly forecasting a level of 24,000,000 on the Dow by 2099."

Buffett's lesson: "If your adviser talks to you about double-digit returns from equities, explain this math to him -- not that it will faze him. Many helpers are apparently direct descendants of the queen of Alice in Wonderland, who said: 'Why, sometimes I've believed as many as six impossible things before breakfast.' Beware the glib helper who fills your head with fantasies while he fills his pockets with fees."

Ouch. But he's right. First, these pension chickens will come home to roost, and likely create a drag on future corporate earnings -- maybe not until later, but it will happen.

Second -- about those double digit returns -- just how is that to happen, anyway, when the economy as a whole grows only 3% or 4% in a good year? Think about it.

Trade free or die

Finally, trade is one of my bigger hot buttons these days. Recent political stumps have called for the rework of Nafta or its elimination altogether. Careful -- it's a two way street. By eliminating Nafta we might protect a lot of American jobs, but we'd lose just as many if not more by hampering exports. Such a policy tried during the Great Depression only made things worse.

Buffett agrees. "Our country's weakening currency is not the fault of OPEC, China, etc. Other developed countries rely on imported oil and compete against Chinese imports just as we do. In developing a sensible trade policy, the U.S. should not single out countries to punish or industries to protect. Nor should we take actions likely to evoke retaliatory behavior that will reduce America's exports, true trade that benefits both our country and the rest of the world."

Prosperity still rules

There's more, but these are the highlights. Buffett is clearly worried about some aspects of the economy, and chagrined at the way at least some corporate American managers, politicians and financial professionals have vacated its proper stewardship.

But he does offer one kernel of optimism in talking about where Berkshire will concentrate future investments: "Despite our country's many imperfections and unrelenting problems of one sort or another, America's rule of law, market-responsive economic system and belief in meritocracy are almost certain to produce everlasting prosperity for its citizens."

I wouldn't bet against him.

Peter Sander contributed to this article.

Jennifer Openshaw is the author of "The Millionaire Zone," CEO of Family Financial Network, and executive director of Debt and Credit Advisors. She hosts ABC Radio's Winning Advice, appears regularly on the Fox Business Network, and serves as an adviser to some of America's top corporations. You can reach her at jopenshaw@themillionairezone.com

Jennifer
Openshaw

Jennifer Openshaw is a nationally known financial leader, innovator, and advocate. She's the author of "The Socially Savvy Advisor -- Compliant Social Media for the Financial Industry" and has advised Fortune 500 companies, including Microsoft.

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Jennifer
Openshaw

Jennifer Openshaw is a nationally known financial leader, innovator, and advocate. She's the author of "The Socially Savvy Advisor -- Compliant Social Media for the Financial Industry" and has advised Fortune 500 companies, including Microsoft.

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